Roger J Kerr warns about the serious damage being done to the economy by the high currency

By Roger J Kerr

Following the plunge from the highs of 0.8800 down to 0.8000 in early August when sharemarkets tanked on the weaker global growth outlook, the NZD/USD exchange rate has zigzagged between 0.8150 and 0.8400 in still quite volatile FX markets.

The attitude, decisions and statements from central bankers is playing an increasing role in determining the immediate direction and pricing of the NZ dollar.

Expect the US$ to weaken

Should the US Federal Reserve implement a QE3 monetary stimulus the US dollar itself can be expected to weaken against all currencies as additional supply of USD’s comes onto the markets. US economic data trends between now and the September Fed meeting may well determine the Fed’s decision. Employment and ISM manufacturing economic data this week will be early indicators as to whether the US economy is pulling out of its winter slump or not.

Expect the AU$ to strengthen

The Reserve Bank of Australia’s Governor Glenn Stevens is not moving away from his earlier view that the mining/commodities boom in Australia will see the economy through despite very weak domestic economic indicators. He still sees inflation risks ahead and his latest speech caused the Australian interest rate markets to remove some of their future pricing of official interest rate cuts. The AUD pulled back from $1.1000 to $1.0300 against the USD on the weaker global growth story three weeks ago.

However, it has strengthened back to $1.0600 since, as the US contemplate further loosening and the RBA virtually rule out any monetary loosening. The NZD/USD rate follows the AUD/USD rate very closely and for the meantime the RBA monetary stance is dominating the NZD direction.

Expect the euro to weaken

The European Central Bank has operated completely independently and separately to European political leaders in addressing the fiscal deficit and debt problems besetting the European economies. The ECB increased their official interest rates to 1.5% in March, which now looks like a policy mistake in the face of weaker economic growth and receding inflation worries.

An interest rate cut in Europe to help consumer spending recover would seem necessary and that would weaken the Euro exchange rate against the USD from its current level of $1.4500. The Swiss do not want their currency any stronger and are intervening to stop its appreciation; the Germans are in the same boat as their export growth suffers from the Euro being too strong.

Expect the NZ$ to weaken

Focus will shift on to the Reserve Bank of New Zealand on 15 September with the quarterly Monetary Policy Statement. The tone and message from Alan Bollard can be expected to be totally different to what the RBNZ were saying in June. The outlook for the NZ economy in 2012 is now much more uncertain as lower global growth, lower agricultural export commodity prices and the high NZD/USD exchange rate all combine to drag growth down from previous forecasts of +4.00% to considerably lower levels.

While the NZ dollar stays above 0.8000, the RBNZ cannot raise official interest rates. The 15 September RBNZ statement could well be considerably more dovish than what the markets anticipate and lead to stand-alone NZD selling.

The high Australian dollar rate against the USD is doing serious damage to investment and jobs in the non-resources industries in Australia. The same is starting to happen to several NZ export industries as well. Wholemilk powder and other key export commodity prices (for example, logs) are now decreasing and diverging from the NZD/USD movements.

A sustained period of this separation of prices is disastrous for the NZ economy and eventually the currency markets will recognise this.

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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com